The Economic Impacts of a Minimum Wage Increase

During the depressed economic conditions of the late 1930s, the Fair Labor Standards Act was passed. This new law created a minimum wage of 25 cents an hour, or roughly 40 percent of the actual average wage. Although this rate was very low and applied to only a limited number of workers, this was the beginning of minimum wage policy in the United States. Let’s examine the economic impacts of a minimum wage increase.

Economists, journalists, and many others in public office offer very compelling arguments regarding the effects a rate increase has on current and prospective employees. On the surface, one may think an increase is completely positive for the American workforce. However, much of the hard economic data paints a different picture. Some of the very people that advocates claim to be helping could be laid off or find that the jobs for which they are qualified no longer exist. In the opinion of many experts, increases have an inverse effect on the job security of many minimum wage-earning workers. When discussing job cutbacks, many believe the workers most at risk are those with disabilities or viewed as the least efficient.

Instead of claiming it increases unemployment, it may be more accurate to say that it reduces employment. When there is an increase, many minimum wage workers are often simply phased out of their current positions. Self-service gas stations, shoe shine machines, and automated phone answering systems are all examples of automation replacing human labor positions. In all three of these cases, there was most likely a point where cost-benefit analysis indicated it no longer made sense for an employee to perform the service. For example, assume the rate was increased by one dollar. Do those earners who receive the increase value the marginal utility of that percent increment as much as the collective job losers value the decrement in marginal utility from the 100 percent loss of losing a job? It is obviously difficult to compare these two figures; still, this is a great question to contemplate.

The long term effects can also be drastic. Most economists agree that increases lure many new people into the labor force. Is this always a good thing? Teenagers in school are the group most likely to enter the work force due to a higher rate, causing very harmful repercussions. For the teenagers dropping out of school to work, this can lead to a significant reduction in lifetime earning potential. In addition, these newly employed teens make it more difficult for needy welfare recipients to find employment. Data indicate that welfare mothers in states which raised its rate stay on welfare 44 percent longer than welfare mothers in states which did not. This example illustrates how economic decisions can cause a chain reaction of effects on society. In addition, an increase drives up domestic labor costs, actually encouraging this shift of jobs overseas. Every time there is an increase, domestic labor looks less competitive when compared to many foreign labor markets.

Advocates for higher rates argue that it would greatly benefit working families. Because the rate does not go up automatically with inflation, it has not kept pace with cost of living increases. Many politicians tend to think that raising the wage lifts families above the poverty line, causing a ripple effect on wages across the board. They feel this is because after a mandated increase, employers often also raise the wages of those earning above the minimum wage rate. The intended end result is increased consumer buying power and an overall stronger economy.

On paper this idea may sound good, but in reality businesses may eliminate jobs in response to the higher labor costs they face after an increase. In essence, these changes can actually hurt the economy by dampening economic development.The end result is higher unemployment, especially among young, poor, or unskilled workers. Increases don’t effectively target the poor, since the main benefactors are teenagers from middle-income homes who take on part time employment.

In conclusion, instinctively one may think a minimum wage increase is the right thing to do. After all, it seems like a reasonable way to redistribute income and help reduce poverty. A higher rate unfortunately means fewer jobs for low-income Americans and can also help trigger a recession. Evidence also suggests that a higher rate tends to actually increase, rather than reduce, poverty. Moreover, the national income data show that Americans are extremely mobile with respect to income status; a large percent of the working poor progress to the middle class a few years later. This happens in part because holders of low-paying jobs work their way up, becoming more productive through on-the-job training. By denying workers initial employment opportunities, the minimum wage can thwart the potential for economic improvement that comes through hard work and learning.

Comments

Here is what is missing:
An increase in the minimum wage doesnt mean a change in the required productivity of a business. If a company needs to produce 10 widgets per day and can only do it with 2 people, the wage will not matter if it is going up against deficient productivity. No business owner in their right mind would lay someone off and sacrifice productivity.
Also, by raising the minimum wage, you are increasing the disposabel income of the population with the largest marginal propensity to consume (as opposed to save): Poor People. What is better for the economy: Giving a millionaire 1 million extra dollars, or giving 100 poor people and extra $10000? Answer: the latter.
Therefore, and increased wage increases demand. when demand is increased, economic growth ensues. I understand that this may not jive perfectly well with a labor equilibrium model, but in real time, this is what happens. There is a great study done based on a minimum wage increase in New Jersey (google it, cant post links), that saw no increase in unemployment.